Oligopolistic Markets

Question 1

What is an Oligopoly?

Answer 1

An industry dominated by a few large firms.

Question 2

What are the main characteristics of an Oligopolistic market?

Answer 2

• A few large firms dominate the market.
• There are high barriers to entry (e.g., sunk costs (costs you would not recover if you left the industry - such as advertising and R&D) and brand loyalty.
• Maximising profits may not always be the firms main objective - increasing market share is often more important to firms.
• Firms try to differentiate products to get some price-making power.
• Firms often use non-price competition (usually) - brand image, advertising and quality of goods.
• INTERDEPENDENCE - always take rivals reactions into account when making decisions.

Question 3

There are different possible ways that firms in Oligopoly will compete and behave. What does this depend upon?

Answer 3

1. The objectives of firms - e.g., profit maximisation or sales maximisation?
2. The degree of cons testability; i.e. barriers of entry.
3. Government regulation.

Question 4

What are the different possible outcomes for Oligopoly?

Answer 4

1. Stable prices - through kinked demand curve - firms concentrate on non-price competition.
2. Price wars (competitive oligopoly)
3. Collusion - leading to higher prices.

Question 5

What is the Kinked demand curve?

Answer 5

This model suggests that prices will be fairly stable and there is little incentive for firms to change prices.

Instead, firms compete using non-price competition methods.

• It assumes that firms seek to maximise profits.
• If they increase the price, then they will lose a large share of the market because they become uncompetitive compared to other firms. Therefore demand is elastic for price increases.
• If firms cut price then they would gain a big increase in market share. However, it is unlikely that firms will allow this. Therefore other firms follow suit and cut-price as well. Therefore demand is inelastic for a price cut.

This suggests that prices will be rigid in Oligopoly.

The diagram suggests that a change in marginal cost still leads to the same price, because of the kinked demand curve. Profit maximisation occurs where MR = MC at Q1.

Question 6

What evaluation point are there of the Kinked Demand Curve?

Answer 6

• In the real world, prices do change.
• Firms may not seek to maximise profit, but prefer to increase market share and so be willing to cut prices, even with inelastic demand.
• Some firms may have very strong brand loyalty and be able to increase the price without demand being very price elastic.
• The model doesn’t suggest how prices were arrived at in the first place.

Question 7

What is the Concentration Ratio?

Answer 7

The Concentration Ratio is the total market share held by the largest firms in the industry.

e.g., a five-firm concentration ratio shows the percentage share of the five largest firms in an industry.

Question 8

How do you calculated the Concentration Ratio?

Answer 8

Add up the market share percentages held by the largest specified number of firms in an industry. The concentration ratio ranges from 0% to 100%.

*In Oligopoly, typically the top 5 firms have a >60% concentration ratio.

Question 9

How does interdependence cause uncertainty?

Answer 9

This is uncertainty in competitive oligopoly as a firm can never be certain how other firms will react to its price, marketing and output strategy.

If a firm raises or lowers its price, will rivals follow suit, or will they maintain their current prices steady in the hope of gaining sales and market share?

Question 10

What is Competitive (non-collusive) Oligopoly?

Answer 10

This exists when the rival firms are INTERDEPENDENT.

This means each firm must take account of other firms’ actions and reactions when forming a market strategy, without Cooperation or Collusion.

Question 11

What is a Collusive Oligopoly?

Answer 11

This is where firms work together to determine price and/or output.

Question 12

How does a Collusive Oligopoly reduce uncertainty?

Answer 12

This reduces uncertainty that may exist among firms in the industry regarding pricing and output decisions of rivals.

Question 13

What is an example of a Collusive Oligopoly?

Answer 13

A Cartel.

Question 14

What is a Cartel?

Answer 14

A cartel is an example of collusive arrangement where oligopoly forms agree to fox prices and/or output between themselves.

Question 15

Give an example of a famous cartel.

Answer 15

The Organisation of petroleum Exporting Countries (OPEC).

Question 16

How many types of Collusion are there?

Answer 16

Two.

Question 17

What are the types of Collusion?

Answer 17

1. Tacit Collusion
2. Overt Collusion

Question 18

What is Tacit Collusion?

Answer 18

This is where forms appear to be organising prices and/or output between themselves without a formal agreement having been made.

Question 19

What is Overt Collusion?

Answer 19

This involves a more formal, open agreement.

Question 20

What is the difference between Cooperation and Collusion?

Answer 20

Cartels achieve a better outcome than competitive behaviour for Oligopoly firms - but this result is unlikely to be good for consumers. This is why cartels are usually judged to be illegal.

However, some forms of cooperation between oligopoly forms may be justifiable and in public interest.

Question 21

What are the advantages of Oligopoly?

Answer 21

• Economies of scale
• High profits
• Innovation and Research and Development (R&D)
• Competitive pricing (price wars may happen in the short-run)
• Stability in the market

Question 22

What are the disadvantages of Oligopoly?

Answer 22

• Lack of competition - if firms are colluding
• Price fixing and collusion
• Reduced consumer choice
• Barriers to entry for new firms
• Potential for anti-competitive behaviour